tv Bloomberg Real Yield Bloomberg July 7, 2018 2:30pm-3:01pm EDT
jonathan: from new york city for our viewers worldwide, i'm jonathan ferro with 30 minutes dedicated to fixed income. this is "bloomberg real yield." ♪ jonathan: coming up, solid payrolls growth shows there is still more room to run for america's labor markets. shots fired in the u.s.-china trade standoff, newly implanted -- implemented trade tariffs hanging over investor sentiment, and trade-off brings one more use to flatten the curve. the flattest since 2007. we begin with a big issue, another solid payrolls report. >> i think this is a very solid report. >> that was pretty encouraging. >> this is a great jobs report.
>> certainly a very good jobs report. there is no doubt about that. >> it looks like it is bad news when the unemployment rate rose up. but if it goes up because people are quitting their jobs more and heading back into the labor force, which is really what we saw in the data, then that means it is a really, really strong market. >> it is an all-around good news story, i believe for the near term. >> this won't change the fed to change course by itself. a few more reports in this direction, if we do see a wave of people coming back to the labor force. i would not expect that, but as it does seem to be the case, it could cause an adjustment in their thinking. >> the fed will hike at least once more. why is it not more than that? simply because wage growth is still sluggish. >> the fed is going to go -- i would argue they will go another two times this year, but i wonder how much they are going to go if the economy starts to bend down a little bit, and the front end of the curve today is pricing in pretty close to the peak of where the funds rate will go. jonathan: joining me here in new
york city is ira jersey from bloomberg intelligence and krishna memani from oppenheimer funds. plus coming to me from london, i am pleased to say iain stealey , from jpmorgan asset management. let's begin with you krishna. , solid, solid, solid. it is all i heard this morning. is that what it is? krishna: it was across the board reasonably good. good for risky assets, for sure. good growth in employment. so telling us overall economic growth is decent. the payroll wages are stable. , so everything is playing out according to plan from the fed's perspective. jonathan: iain stealey, i was looking at the numbers this morning, and everyone turned around and said they were absolutely solid. but ahead of the numbers through the week, it was the least anticipated payrolls report i've seen so far in 2018. why do you think that was? iain: i think it was one of those things where actually when you look at the major issue, jobs in the u.s. are fine. the u.s. economy is fine. everyone is focusing on tariffs, and everyone is concerned about
trade, and that is what has been driving the market. i would agree with what was said on the payroll report. it was solid. it had a little bit of everything. you had good job growth, but the wages did not pick up. that probably means the fed does not need to go any quicker than what they are doing at the moment. what we are seeing is risk assets have done really well on the back of it. jonathan: ira? ira: it definitely was. if you look at the paycheck of the economy, this is a chart i look at. you can look at the hours worked, the amount of people working times how much they get paid per hour, and this is growing at the same rate that we did before the crisis. so you know, saying this is a solid number i think in some ways is a little bit of an understatement. this is really an on trend and quite a good number when it comes to job growth. krishna: i think job growth is good. i think the differences this is happening at 3.5% unemployment rate as opposed to 5%, or 6%, or 7%. i think that is the most remarkable thing. and it gives water to the thing
that the fed really does not have to tighten. maybe in 2019, they will be backing off the path they are down, two or three tightening in 2019. jonathan: it raises an important question. i remember moving to the united states back, and i was told get ready for payrolls growth to moderate. we are not going to be able to continuously print 200k, 200k. guess what we are doing? we are printing 200k. how is that still possible, iain? iain: i think it shows there is a lot of slack in the economy, you saw that today with the great number, but the unemployment rate goes up and the participation rate goes up. it shows what the federal reserve has been saying for a while now, that there is still slack, which is why they are prepared to go fairly slowly, keeping this glacial pace as opposed to historical cycles. we think that continues. we do think there is slack. we could see some good prints going forward as well. jonathan: ira. ira: i think krishna is right. i think 2019 is when we will see the end of hikes.
one of the questions is, when the curve starts -- continues to get flatter, because the federal reserve continues to hike, even with these good jobs numbers, you wind up getting a lot of fears that somewhere in the future we are going to have a recession. flat curves, two to four years, before tend to precede a recession. so the question then becomes how worried is the fed about that. you heard heard the minutes , yesterday, the fed is looking at it. the fed is worried and looking at the curve. but there is not much they can really do about curve flattening except change their own policies. jonathan: so the consensus view i think for most people in the market and certainly most people who sit around the table with me every friday at the end of the week is to play the flattener. i am not asking the question, how much juice is left to squeeze and how much upside is there in two-year yields? krishna: i think if it is as flat as it is, the amount of juice has already been factored out already, so it is really very small. i think what that is telling you is that basically, the fed will be forced into stopping unless
they want to get into a recession. so if it inverts further, that means the recession is coming down the pike because they are going down the path of policy tightening in a meaningful way. jonathan: but i have heard this argument of the past several months, but i do not see a federal reserve that is too worried at this certainly they point. are looking at the yield curve, but they were not stopping at 50 basis points. they are not stopping at 30. when do they stop? iain: i think they will keep going for a while. i think when we look at what is going on in the economy, it is a very different environment to maybe other cycles because you have that big amount of money coming into the market from the european central bank, from the bank of japan -- that caps that premium in the long end, and i think that is what has kept yields down. i think what will be interesting is the second half of the year. if you look at it today, it is 30 basis points. roland kerry, which is so important from a fixed income basis is around about seven bits
, a quarter. you need that to be at 15 basis points for the flattener to make you money. yet, we are in an environment where we are going to see all this supply coming. we are seeing quantitative tightening out of europe, so it depends, are we still going to see that demand from long and bonds if the fed keeps going up? i would not be surprised if we see some near-term steepening. jonathan: this is a curious situation, that the federal reserve has not gotten us to a real rates world yet. the federal reserve has not gone through neutral yet, yet we are having a conversation about the federal reserve perhaps having to stop next year. why? krishna: this is a new world. that is fascinating. the fed was trying desperately to get real rates up, and the markets want no part of it. and and i think the structural because from a cyclical standpoint, things are quite good, but the structural issues we want to sweep under the carpet. they are not going away. and i think this is going to be with us for a long period of time. real rates are not rising meaningfully. if they rise meaningfully, we will have a recession. and the fed does not want that at all. jonathan: ira, is it a new
world? ira: it absolutely is a new world. one of the things we have to ask ourselves is are we at neutral? you suggested maybe we are not at neutral yet. in the fed's funds rate maybe we , are. there is no way to actually -- you know, there are tons of different estimates, right? my estimate for the real rate might be 3%. so two more hikes we are there. , that is not saying very much. but other people might think it is 2%. which means that the fed has already reached neutral and they are going to be tightening. so you look at things like the yield curve. i think field curve point is very important because i think one of the reasons term premium is so low and premium terms are so flat is because we are nearing the real rate being met by the front end. you know as we do that, if the , fed keeps on tightening then effectively, they are tightening beyond the neutral rate, and that is where policy mistakes come in. jonathan: krishna, what do you think of people who turn around and say the long end of the curve is more capturing the global bond market story, the trade story has been just another excuse to demolish the curve even flatter?
if i got rid of the trade story today, just like that, magic, how much steeper with the yield curve be? krishna: i think it would be slightly steeper, but i think the likelihood that it would be at 3.5% or 4% is not in the context. with or without trade, the key issue is there are structural issues facing the global economy. it is not just it is not just , trade related pressures. inflation is not rising globally to a meaningful level. that is not something that is going away. jonathan: so let's explore this further. if you think the federal reserve eventually gets to a point where they need to slow down, what stops the balance sheet unwind first, or the rate hikes? krishna: i think balance sheet unwind, in my judgment, will stop first, because that is something they are already talking about to some extent. because of reserve problems or something like that. with all of these things they have created with new regulations, i do not think they have a pretty good idea of how reserves are being used, and they are at a loss to explain the current situation. jonathan: but i guess i am
trying to explore what is the methodology to understand what should be the appropriate level of the balance sheet? how do you do the math on that? how do you know? are we just putting our finger in the sky and saying is is $2.5 trillion, $3 trillion, what is it meant to be? ira: realistically, the only way you can know the balance sheet is when reserve demand picks up. and this is why, this is one of the reasons why there have been discussions about that. what happens is there is this interest on excess reserves, and that was set at the upper bound of the range that the fed is trying to set the fed funds rate. but this spring, right after they had started to unwind the balance sheet, you started seeing the effective rate, the actual traded fed funds rate start to creep higher and higher and higher. and because of that, they said oh, well maybe this is a reserve problem. i do not think it is. i think there are other factors that are involved, but this is one reason why some academics and some others are talking about stopping the unwind. jonathan: ira jersey, great to have you with us from bloomberg intelligence. sticking with me along with krishna memani from oppenheimer funds and iain stealey from j.p. morgan asset management.
jonathan: i am jonathan ferro. this is "bloomberg real yield." i want to head to the auction block now, where there was a condensed treasuries schedule due to the holiday shortened week. the weekly auction of four-week bills saw investors place bids for 2.5 times the dollar billion amount offered. treasuries also sold $48 million of three-month bills with a 2.62 bit to cover ratio. the bid to cover ratio was the lowest level in a decade. meanwhile, in junk bonds, $15 billion was priced in june, making it the slowest issuance for that month since 2013. high-yield also posted the
slowest second quarter in eight years. and finally over in europe, corporate debt sales had the worst first half in seven years. issuance of investment grade corporate bonds slumped 30%. just 149 million euros. this week a really interesting piece came from hsbc steven major, highlighting the unfolding credit squeeze. in a note that his team wrote, they said the following. "over the last six months, we've compiled a long list of individual surprises which appear to be more than coincidental. when viewed alongside the decoupling of growth half, tightening u.s. financial conditions, and repricing of risky assets, we have all the hallmarks of a slow motion credit crunch." still with me to discuss is ira jersey from bloomberg intelligence, krishna memani from oppenheimer funds, and iain stealey from jpmorgan asset management. iain, what do you make of that? that outside of the united states, evidence is building that we are starting to see financial conditions tighten? and maybe, in the terms of the team at hsbc, a slow mo credit crunch?
iain: i think when you look at that he is completely correct. , we have seen this kind of list of idiosyncratic events that have built up, and they have hurt risk assets. and we have seen some significant underperformance. i do feel though that when we look especially in the u.s., , especially what is going on there, we could well see q2 could print close to 6% of a nominal growth number. that is still a good environment i believe for credit and i , believe areas for the high-yield market and, like you highlighted, very low issuance this year, you know there is the , ability for that market to perform. i still think those spreads are attractive enough and the default rates are low. even if it is a very slow-mo credit crunch, you have a lot of carry baked into that sort of market. jonathan: low insurance can be a positive depending on why we have low issuance. there is an argument to say we have so issuance right now because they can't come to market at the price they like. krishna: indeed, indeed. i think if iain likes the high-yield market, he must like the high-grade market because the contrast between the two
markets in the u.s. is extraordinary. jonathan: what do you make of that right now? krishna: i think the investment grade market is driven by two things. at least the beginning of the year, rising rates, and then a whole lot of issuance basically killed that market. high-yield where issuance was relatively low, and it is not as rate sensitive, defined more equities and equities are ok, if not superlative. i think that is a good thing. but i think your point about emerging markets and tightening financial conditions and you know non-u.s. markets, that is real. and that is something the fed may not care about, but i think by 2019 will have no choice but to care about. and i think that is where the transition will take place. jonathan: so iain, that is what i really want to explore, whether the feedback loop is still sort of there, whether we can get a u.s. economy that responds to what is happening in european high-yield, in emerging market high-yield and asian high-yield and whether there is feedback risk into u.s. credit. right now, on the screen, equity bonds just completely rolling over. enthusiasm about the u.s. economy and u.s. high-yield
is being kind of the most resilient place to be in fixed income through the rest of this year, does that change? iain: i think it does not. and i would sort of disagree on the investment grade side and the high-quality side. when we look at credit metrics in investment grade, there is a reason it has been selling off in the u.s. we have seen leverage ratios picking up. it has been classic late cycle behavior, but we are not seeing that in the high-yield market. high-yield market leverage ratios are still coming down following the energy crisis. so i think there is a bit of a disconnect, and that is why we have seen the underperformance. when we look at the rest of the world and some of the markets there, the european market looks pretty healthy to us on the investment-grade side, but you have got that kind of elephant in the room, the ecb. they are going to stop buying corporate bonds at the end of this year. whereas the high-yield market in the europe, it doesn't have that impact. they have not been buying high-yield bonds. it has been a bit of an unloved market and now trades at a wider spread to the u.s. i think that has a good opportunity over the next six months. jonathan: what do you make of that argument, krishna? krishna: with respect to
leverage, yes. i think the leverage of u.s. hybrid market has gone up, but the debt service -- debt coverage ratio is quite reasonable because of the high level of profitability. so i disagree that that reflects credit concerns in the market. it is just a supply issue far more than anything else when you have lots of large m&a transactions coming through the system in a market where flows into mutual funds have been pretty slow. it is the math is easy. jonathan: here we are talking about a slow-mo credit crunch, the federal reserve, as we can debate whether they have gone neutral or not, but to that extent let's assume they have. , not by very much. if you want to make that argument. my question, how are we going to even get an ecb that can get away from negative rates when we are having a conversation right now about whether they move by 10 basis points in september next year or december of next year? that is the debate right now, really? iain: first, they have to get rid of their quantitative easing program, right? you know slowly but surely, they , are reducing that.
one of the ironies is is that if we wind up with financial conditions continuing to tighten like they are, then you wind up in a situation where the ecb cannot do anything except potentially reverse the quantitative easing program. where, -- how do you quantitatively tighten? how do you raise interest rates in an environment where you have credit conditions that are tightening so much? like, that is a big problem for central banks. and that has been a problem, quite frankly, for japan for the last 20 years. when you reach the zero bound, there's a limited number of policy options that you have, and the ecb may face those exact same policy options. jonathan: krishna. krishna: i think the ecb has even more challenging case from the u.s. from a cyclical standpoint. growth outlook is decent. we are talking about 5%, 6% of nominal growth. that in ecb terms and in real terms is kind of rolling over. it is a really big challenge. it may indeed be that the fed stops tightening at some point, and the ecb does not get any opportunity whatsoever to raise
rates in this go-around. jonathan: krishna memani, great to have you with us from , oppenheimer funds, alongside iain stealey and ira jersey from bloomberg intelligence. i want to get a check on where the market has been, treasuries, and 30s., two year yield up by a mild two basis points. there is your curve flattening. down three on a 10 year yield. five on a 30 year. still ahead, the final spread. the week ahead featuring comments from mario draghi and the new numbers on u.s. inflation. much more in that. from new york, you are watching "bloomberg real yield." ♪ omberg real yield." ♪
jonathan: i am jonathan ferro. this is "bloomberg real yield." it is time now for the final spread. coming up over the next week, we will hear from the ecb president mario draghi and get a new reading on u.s. inflation. plus we have a rate decision in canada, u.s. bank earnings, and political meetings in europe, including the one between president donald trump and the
u.k.'s prime minister, theresa may. still with me around the table, ira jersey from bloomberg intelligence, krishna men money from oppenheimer funds, and iain stealey from j.p. morgan asset management. just some final thoughts on the inflation story. out of everyone i've spoken to, you have been out front, saying we will not get inflation, overshooting and to the upside in any kind of aggressive way at all. where do you see things going now? krishna: so from a cyclical standpoint, we are going there and we may actually overshoot the 2% target. i wouldn't be surprised. but i think the, the fed is being really smart and wise, and basically making up stories to to make sure that they do not use the data point to tighten policy aggressively. and i think that is the right thing to do from a policy standpoint. otherwise they will end up with the policy mistakes. ira: it is not like the market is telling you there is going to be runaway inflation. you look at inflation breakevens and you know 10-year inflation , breakevens at 2.15%ish, that is not runaway inflation.
if you saw the breakeven curve of being very steep, that be something to be concerned about where the fed would be fighting -- hiking more. the market is telling you that inflation is not really an issue. it will not be for a very long time. jonathan: iain stealey, do you have a better understanding under chair powell than you did under chair yellen? iain: i think the reaction front is going to be very similar. he is going to look at the data, he is going to analyze what is going on, and the ultimately the view is that inflation is going muted.in fairly i could pick up near term, but longer-term u.s. inflation is going to be low, and that is going to be kept down by all of the cyclical structural impacts of low-cost providers, the amazon's of this world, and low inflation globally. you know there is no inflation , across europe. there is limited inflation across areas like japan, and that is going to weigh down on global inflation. think they're going to monitor the data, but they are not going to feel they have to go even weaker into the moment.
i think they are going to look through those. jonathan: and given here in the united states, the output numbers are so good, that cannot be a problem. ira: it is not a problem. so that is one of the ironies here. you can have real growth that is ok, low inflation. it is really kind of -- and this is an overused term, but it is a goldilocks kind of economy where you do not have runaway inflation, and you do not have an employment problem. jonathan: guys, it is time for the rapidfire round. you know how we wrap up the program. you go into the boxes with short, sharp questions and i get some quick answers. does the 2-10 curve invert before the end of the year, yes or no? ira. ira: no. jonathan: krishna. krishna: no. jonathan: iain. iain: no. jonathan: have we seen the lowest unemployment curve of the cycle? ira: no. krishna: no. iain: no. jonathan: that was an easy one. can the fed hike five more times without the ecb hiking once? yes or no? ira jersey? ira: no. jonathan: krishna men money? krishna: absolutely not. jonathan: iain stealey. iain: i think they can.
jonathan: raising some big questions. great to catch up with you. krishna men money from oppenheimer funds iain stealey , joining us from jpmorgan asset management. from new york city for audiences worldwide, that does it for us. we will see you next friday at 1:00 p.m. new york time, 6:00 in london. from new york for our audience across the planet, this is "bloomberg real yield." ♪ retail.
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